Interest Rates Rise, Other Assets Moves

The 10-Year bond is almost at 3%, which pretty incredible as in early May it stood at 1.63%.  Depending on your time frame, this is one of the larger moves of all-time:

Since interest rates affect every other asset class and the economy, let’s see how this rise has filtered through and the possible reasons why:

• Emerging market assets have gotten crushed - See India.  Reason:  Investors move out of higher yielding emerging market assets as they now have a higher rate of interest here.  As assets move out, their central bank has to sell Treasury Bonds to accommodate currency flows, reinforcing the problem.

• Mortgage rates are up big - Reason:  Fed tapering includes Fannie and Freddie bonds, which are pooled mortgages.  Less demand via Fed and the market (given the Fed’s move) means higher interest rates on those bonds and the subsequent mortgages tied to them.

Note:  Interest rates rise and bond prices fall.  If there is less demand then the price will fall, thus equating to higher interest rates.

• Real Estate in general hasn’t fared too well - See Homebuilders and REIT ETFs.  Reason:  Higher interest rates = higher mortgage rates (see #2) = higher cost of purchasing a home = less demand.

• Stocks are up - See SPY.  Reason:  Fed’s taper and economic data indicates improving (slightly) economy > higher revenues > higher earnings.  This is a positive change, as in the recent past there have been times where weak data has meant more easing, lower rates, and higher equities. 

Of course other markets are moving, this is just a snapshot. Yet, the following presents the most interesting questions moving forward:

At what point do rising interest rates, or the pace of that rise, compress earnings given higher borrowing costs and lower consumption?  Alternatively, will the economy improve enough to cancel out the earnings hit?  If not, will the Fed un-taper?

While the debt ceiling, government shutdown, Syria, etc. will take all the headlines, to me rising rates and how they filter through the economy are the biggest risks moving forward.  

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

The US No Longer Concerned with Europe?

Crossing Wall Street has an interesting set of graphs that show the S&P 500 versus the Euro.  At least for the end of the year it shows what most market observers probably thought – the US equity market was correlated to the Eurozone.

In October and November the Euro and the S&P 500 were highly correlated.    So as the Euro got stronger the S&P 500 increased in value.  If this seems contradictory, remember as the crisis in Europe grew the appetite for risk would fall and the flight to quality would grow.  Thus, investors would sell stocks and the Euro and move into Treasuries, for example.

What has happened in January?  The correlation has essentially stopped.  What does this all tell me?

• Could be nothing, very small sample size
• If it is something, the big drag from Europe wasn’t so much a slowing economy but a financial system collapse
• The risk of the latter has been reduced, at least for now
• The former was already priced in
• Thus, assuming the correlation means something, negative economic news from the Eurozone will probably have minimal impact on US markets (assuming US data stays positive)
• If however the risk in financial markets comes back, the correlation could come back

Not All Government Debt is the Same

I have mentioned before why US government spending is different than Eurozone government spending.  Recently I read an article by Satyajit Das that highlights some of these, as well as touches on some other government spending issues:

• Since debt rarely gets repaid, the markets focus on the ability to pay the interest and whether or not the debt can be refinanced.
• When borrowing in its own currency (e.g. the US), “a sovereign’s capacity to borrow is only constrained by the willingness of investors to purchase its securities and the cost of that borrowing.”
• When used as the major reserve currency (again, the US) the ability to borrow is increased.
• If there is a large amount of domestic savings (e.g. Japan) the ability to fund is easier.
• A country that can’t print its own money and has high foreign liabilities (weaker Eurozone states) will have a harder time convincing the market it will be able to service the debt and then refinance it.
• This results in higher interest rates, which further constricts the ability to borrow.  This is why the US can borrow more than countries like Greece.
• The more diverse and dynamic the economy, the more diverse the tax revenue streams; thus, the greater the ability to borrow will be.
• Current and expected GDP are huge factors in determining how much a country can borrow.  

So putting this all together, you can see why Europe is fiscally struggling right now – a high % of foreign liabilities in a currency they don’t print and economies with anemic growth outlooks that aren’t diverse.  Further, the resulting higher interest rates creates a vicious circle.

I am not saying the US fiscal situation is in great shape, but from the above comparison you can see why our interest rates remain so low and why we can continue to expand our debt to GDP ratio.  In short, we ain’t Greece.

Macro Domination

Here is a graph from EconompicData, which shows ETF performance in September, October, and most of November:

The above graph paints a picture of what most market followers already knew – there has been a “risk on, risk off” trade over the past few months.  Further, the moves each month were pretty sizable.  Take a look for instance at Emerging Market equities – down 18%, up 17%, and then down 11% each in a separate month!

My big takeaways from the graph are these:

• Given how riskier assets are moving in lockstep, it’s pretty evident that macro data is driving the market and however the macro issues (namely Europe) shake out will ultimately determine the fate of the markets. 
• The size of moves and how quickly they change indicate the markets are very uncertain.

Ultimately, even if my conclusions above are off base you can’t argue that markets aren’t very volatile right now.  If you are struggling with the daily moves, reducing your portfolio’s beta might be a viable solution.  

Spreads and Equities

I commented last week on the value of credit spreads – credit stress, economic conditions, as a possible buy indicator.  This week I came across some graphs that indicate some correlation with the equity market.

The first is the TED spread.  I mentioned this in the last post, but the TED spread is an indicator of credit risk essentially reflecting the difference in yield between short-term corporate borrowers and Treasury Bills.  The higher the spread,  is the greater the risk in the credit markets. 

The graph here (via Infectious Greed) shows the inverted TED spread versus the S&P 500.  If you look at the graph, as the TED spread moves higher equities in general move lower. 

Another graph that caught my eye shows the High Yield spread (High Yield Bonds over Treasuries) versus the S&P 500.  Again, as the spread moves higher equities in general move lower.

Now looking at both graphs you can see the TED and HY spreads are trending wider.  Is this bearish for equities?  Not necessarily as these spreads appear to coincide with stocks (i.e. one is not leading the other). 

Thus, when the spread and stocks diverge from their past correlations (as both of the aforementioned do now) it is a decent indication that one of those markets is due for a correction – one way or the other.  

How the Credit Spread Works

A credit spread is the difference between the yield on one bond and another.  For this post, I am going to focus on the spread between risky bonds and government bonds with similar maturity. 

A widening spread is when the difference in yield between the two bonds (risky bond yield vs. government bond yield) increases.  A narrowing spread is when the difference in yield between the two bonds decreases. 

So what do widening and narrowing spreads tell you?

• Credit Stress:  Certain spreads (TED, German bunds vs. European Peripherals, Treasuries vs. HY, etc.) can indicate there are problems in the credit market.  Widening spreads tend to be a good indicator of this.  On flip side, narrowing spreads indicates the credit market is becoming more functional.
• Economic Conditions:  Widening spreads between Treasuries and Corporates may forecast that an economic slowdown is on the horizon.  On flip side, narrowing spreads may forecast an uptick in the economy is coming.
• Time to Buy?  This gets tricky, but as a spread widens so does the buying opportunity.  Bond yields and prices move in opposite directions.  So if the yield on risky bonds increases relative to the yield on government bonds the price of the risky bonds falls.  The lower the price the better the value.  On the flip side, narrowing spreads might indicate certain bonds are now pricey.

There are some caveats when it comes to buying on a wide spread, namely that spreads can continue to rise and/or the spread can stay the same, but the yields of both bonds rise. 

Regardless of whether or not spreads can provide buy or sell signs, they are certainly a good indicator that deserve attention. 

Occupy Wall Street –Hippies Hipsters, Union Members, Socialists, get all the press attention

By now most have witnessed the large protests, which started on Wall Street have spread around the world.  Hippies, hipsters, union workers, socialists, and other angry people are present to voice their displeasure over the current system.

I have to admit, when first glancing at the videos and pictures I start to think “how fun  it must be to disregard hygiene for weeks and participate in drum circles”.  I also am amused by the irony of those who protest the establishment while Skyping from an iPhone 4 in J. Crew khakis.

 

Having said that, many in the crowd are ordinary, college educated, working Americans.  I would wager a few, maybe many have worked hard their whole lives only to have their savings evaporate and their jobs lost.  The system failed them. 

Just a guess however, but I would think the ratio of wacko people to sensible people is similar to that of a Tea Party rally.  But regardless of who is protesting, isn’t the message more important?  Here is a video from Yahoo’s Aaron Trask:

At the end of the video he makes the following points about “those who mock the protesters, what are they defending”: 

• Crony capitalism
• Bank bailouts
• Rising income inequality
• The slow death of the American dream

Taking a stand against any of those issues doesn’t seem even remotely close to unreasonable, just as those at Tea Party rallies, who are mocked by the left, have valid points on bureaucratic corruption and/or incompetence. 

My non-partisan point is that when it comes to massive protests or rallies the crazies will get all the attention, but they do bring up sensible positions that MUST be addressed if we will continue to prosper as a nation.      

Europe – It’s a Start

Some of my past posts highlight just how important a solution is to the European crisis.  A solution might be on the way.  Recently, French President Sarkozy said “We will recapitalize the banks… in complete agreement with our German friends.” 

A key to such a step appears to be the holders of Greek debt taking a haircut (e.g. a bond has a face value of $100 and the investor accepts $80).  Further, there also seems to be less certainty that Greece will stay in the Euro.  Ultimately, there should be a plan delivered by early November at the latest.  

Just how good last week’s news is will ultimately depend on the goal, strength, and the execution of that plan.  I am unsure how much money is needed for recapitalization, how much Greece leaving the Euro will impact the global economy and markets as a whole, and what the implications of taking these haircuts will be.

However, the success of such a plan will depend on whether or not a PIIGS (Portugal, Ireland, Italy, Greece, Spain) fallout can be contained, if this is a systemic solution (i.e. not the banks), and if the plan can be applied  a timely and effective manner. 

“Contained”  in this instance means preventing the credit markets from freezing up.  As I have outlined before, if such a freeze up happens, it will likely spread to our markets.

In my opinion, this is the central overriding issue facing our markets through at least the end of the year.   Let’s hope the plan is enough to prevent liquidity from drying up and punishes the imprudent while protecting the system.  

Household & Financial Sector: How We Fix It – Part 3

In my previous posts, I have outlined the problem, what went wrong, and how we got to that point. 

So how do we fix it? Below a list a host of things that need to happen, the problem is all of these don’t happen overnight and take time.  How much?  I am not quite sure.

• Consumers and financial institutions need to get back to sustainable debt levels.  Inflation and write-downs can help with this. 
• The consumption economy needs to shift into more production and exporting. 
• Borrow less, spend less, and save more.  Capital saved now can be invested in the future.
• Regulators need to make sure the system that lead to the collapse is no longer in place, and find a way to assure this system or another can’t be recreated.  

It’s not a welcome answer, but it’s the only way we can cure our debt problem.  It’s going to be no easy task, but once the aforementioned items are accomplished we should have a launching pad for more sustainable, steady growth (and subsequently more stable markets).  Balance sheets will be cured and responsible, modest loan supply and demand will return.  The private sector will then be able to be self-sustaining.

That is why I am a proponent of fiscal support.  As the private sector continues to deleverage, that growth will need to be made up somewhere or the economy as a whole will contract.  This is where the federal government can step in. 

Of course, whether or not they will spend wisely and make investments that will lead to future growth is entirely debatable.  

Household & Financial Sector: What Went Wrong and How We Got There – Part 2

I outlined in the last post the problem on the consumer debt level.  So what happened? 

1. Eventually the market realized income levels couldn't support the liabilities.  As a result the loan market dried up.  Fewer loans meant less money flowing into various asset classes, which led to a corresponding devaluation of those assets that were artificially inflated by the excessive leverage, creating a cycle in which it continued to feed upon itself.  It follows that industries, which were dining at the bubble table, began to contract.
2. Aside from purchasing assets, funds from those loans were also being used for consumption.  No new loans meant far less consumption.  Further, the depressed asset values depressed the psyche of the consumer, from one of exuberant consumption to one of saving at best and desperation at worst.

As illustrated above, the aftermath of a “deleveraging” cycle is fewer loans supplied and demanded.  This in turn negatively impacts growth going forward and leads to uneven economic outcomes as households and financial institutions lick their wounds, and repair their balance sheets.

So why did this happen?  There are a multiple of reasons, but my favorites are listed below:

1. Ultra low interest rates from 2001 to 2005 led to a misallocation of capital into various asset classes, artificially inflating their value. 
2. De-regulation of the financial services industry assisted in allowing for higher leverage, opaque markets, and increased risk taking.  Regulators, legislatures, and the Fed made this possible, then fell also asleep at the wheel.
3. Decreased lending standards.
4. Low interest rates had a negative effect on money managers, who given the low rates had to stretch for yield.  This was facilitated by ratings agencies rubber stamping  AAA  ratings on questionable tranches of debt , and the widely held assumption that markets are efficient.
5. Moral hazard and the “Too Big to Fail” mentality.  This can be traced back to Chrysler and LTCM.
6. Psychology of the American Dream – everyone stretching for the next best thing. 

I have outlined the problem, what went wrong, and how we got to that point.  The last post will be how we fix it.

Household & Financial Sector Debt: The Problem We Face – Part 1

I think it’s really important to spell out why I think debt is at the center of the economic issues, which we are facing.

High unemployment, the tepid recovery, and market volatility can be attributed, in large part, to the deterioration of household balance sheets.  Graphs do a great job illustrating this.

Here is household liabilities divided by GDP:

And household liabilities divided by income:

Lastly, household net worth:

These graphs only represent 1990 to the present; however, a look back a few decades indicates that all rose steadily until 1980, where the charts all spiked, then spiked again in 1990; however, none of those spikes came even close to the boom beginning in the early 2000’s.

Here are some takeaways, which have lead to the problems we are facing:

1. Household leverage spiked without a corresponding jump in GDP.  Thus, the spike in leverage was unsustainable as there was not a corresponding jump in production.
2. Further, as leverage rose without a corresponding rise in GDP one could reasonably assume that resources were being misallocated, thus pushing values higher to unsustainable levels (e.g. housing).
3. At the same time, incomes were not rising in line with increase in liabilities.  As such, households were taking on more debt without the cash inflows to substantiate such a rise. 
4. How were they getting loans?  Looking at the rise in net worth, it is reasonable to assume households were ramping up their borrowing due to an increase in their personal assets (e.g. housing).

A parallel situation was present in financial institutions; however, for simplicity I only covered the consumer.  In my next post, I will provide more detail on what went wrong, and how we got there.   

Germany Says No!

In my last post I highlighted a recent interview by George Soros where he outlined a solution for the Eurozone’s problems – Eurobonds; however, Germany was against that plan.  Why?

Politically it is unpopular.  German citizens are essentially paying for problems in other members.  To me this seems a bit unfounded as Germany is a creditor nation, meaning they lent the money to the indebted nations in the first place.   

Since Germany lent the money to these countries, a default or financial crisis from a Euro unraveling would certainly have a major adverse impact on the German economy.  It logically follows that the rest of the Eurozone and global economy would also suffer.   As a result, at some point there needs to be a universal solution as the pain will be felt by debtor and creditor nation alike.

Currently indebted nations are cutting back on public spending, experiencing falling wages, and reducing social safety nets.   The markets still aren’t buying that this will solve the crisis – sovereign interest rates are rising and European bank shares are falling.  Further, those nations are experiencing more social unrest as a result of the measures taken to date.  As this builds, so does the geopolitical risk.

Basically the action taken to date appears to be grossly inadequate.

Is the solution Eurobonds?  I don’t know with any certainty; however, the risks associated with a Eurozone collapse are great.  As such, we have to see a discussion of real solutions sooner than later and Eurobonds should be one of the options on the table.  Like most problems there is no magic bullet, and it will require multiple tactics as things evolve.

Soros on Europe

George Soros is arguably the most well known, highly successful macro hedge fund manager around.  In a recent interview he sat down with Der Spiegel to discuss the issues facing the Eurozone, among other things.

I have commented on the main issues before, but Soros outlined why these problems need sorting out as well as some potential solutions.

Essentially he states:

1. A Eurozone breakup would lead to a banking crisis that would spiral out of control. 
2. A European fiscal authority is needed to re-finance indebted members on more reasonable terms. 
3. To do this the authority would issue Eurobonds.
4. These bonds would be backed by the union.
5. Germany, being the largest country with the best credit rating and largest surplus in the EU, is essential to making this work.

In short, the Eurozone acting as a whole would issue bonds to help member nations that are financially under pressure (Greece, Portugal, maybe Italy, etc.).  These bonds would in part be backed by Germany who is the key player in the whole process.

Seems good to me.  The problem?  Germany doesn’t want any part of that quite yet. 

My next post will comment on Germany’s objections, as well my take on what they should do.

How Rare are “Black Swans”?

“Black Swans” are rare events by definition.  However, I would contend many of the events that people classify as “Black Swans” happen with greater regularity than most think.  Doug Kass compiled a list (via Barry Ritholtz) of “Black Swan” events in the last ten years:

• Sept. 11, 2001, attacks on the World Trade Center and Pentagon;
• 78% decline in the Nasdaq;
• 2003 European heat wave (40,000 deaths);
• 2004 Tsunami in Sumatra, Indonesia (230,000 deaths);
• 2005 Kashmir, Pakistan, earthquake (80,000 deaths);
• 2008 Myanmar cyclone (140,000 deaths);
• 2008 Sichuan, China, earthquake (68,000 deaths);
• Derivatives roil the world’s banking system and financial markets;
• Failure of Lehman Brothers and the sale/liquidation of Bear Stearns;
• 30% drop in U.S. home prices;
• 2010 Port-Au-Prince, Haiti, earthquake (315,000 deaths);.
• 2010 Russian heat wave (56,000 deaths);
• 2010 BP’s Gulf of Mexico oil spill;
• 2010 market flash crash (a 1,000-point drop in the DJIA);
• Surge of unrest in the Middle East;
• Thursday’s earthquake and tsunami in Japan

Now frankly I don’t recall all of these events; however, all of them had a drastic human toll and/or economic toll.  So when it comes to portfolio management, and as the linked articles allude to, a few important things stand out:

1. “Black Swan” events are more frequent than one probably anticipates
2. “Black Swan” events are drastic
3. “Black Swan” events are unpredictable
4. Given the first 3 bullets an investor should probably have a plan in place when a “Black Swan” event happens

To elaborate on the last bullet, I am not advocating building a portfolio around the extremes (except in a few possible cases).  What I am saying is that the time to plan for a “Black Swan” event is not after an event, but beforehand given that you don’t know when such an event will take place.  Put it this way, the time to buy insurance on a house is not when it’s on fire. 

Short-Selling Isn’t So Bad

First, short-selling is when I borrow shares and then sell them.  I buy those shares back at a later date and return them to the lender.  If the stock moves down I make money. 

For example, I borrow a stock at $45 and sell it.  I get $45 in cash.  A few weeks later the stock is at $35, I buy it, and return the shares.  I made a $10 profit. 

I tend to think short-selling gets demonized by many, especially corporate executives looking for an excuse, but it serves a very useful purpose:

• Price Discovery.  Increased selling pressure helps stocks find their true value.  Let’s say a stock is trading at $50 a share.  A short-seller believes the true value is $30.  In this instance the short-seller is correct and the stock is worth $30.  The market will eventually reflect this value; however, the inability to short-sell the stock will only make the stock’s fall to $30 more drawn out. 
• Short Covering Rally.   When markets crater, short-sellers often put a floor on the losses.  Why?  They lock in their gains by buying the stock back.
• Liquidity.  The more traders of a security the more liquid.  The more liquid a stock is the easier it is to enter and exit a position.  More short-sellers = more traders = more liquidity.      
• Hedging.  Being long a stock and going short in the same stock can help mitigate loses. 
• Finding the Truth.  It helps expose companies like Lehman.  If a short-seller can illustrate effectively why the company is worth less than the market perceives it, he or she can assist in finding the true value of a company. 

Further, executives and commentators are usually pumping up a stock.  Why isn’t that rumor spreading met with the same vitriol? 

There are probably more reasons why short-selling is a necessary evil.  I just wanted to provide a bit different perspective by illustrating why short-selling bans, like what is taking place in parts of Europe right now, are at best ineffective (price discovery) and at worst harmful (short covering rally, liquidity, hedging, finding the truth).

My Thoughts on the Recent Market Volatility

No one can fully explain the market movements.   Thus, here is a broad list of fundamental data or happenings that may have helped sparked the last few wild weeks:

• Weakening macro data that could lower earnings estimates.
• European debt problems seem to be escalating with focus moving from the PIIGS to Italy and French and German banks.
• Lack of confidence in Washington.
• Possible overheating in emerging markets.  Emerging market equities have performed worse than domestic equities this year.

I am 100% sure this list doesn’t include everything, but I don’t think it’s a stretch to say these are some of the bigger headwinds.

What I am struggling with is why any of the above would lead to increased volatility now.  When I read that list, it contains nothing that in my opinion should sneak up on investors.  Thus, I have come up with a few possible reasons on why now:

• Psychology.  There was a catalyst that got people selling, once they started others got nervous and pulled the plug.
• Margin Calls.  As the market starts moving down hedge funds or institutions that buy stocks on margin (borrowing to buy stocks) get margin calls (they need to put up cash to meet the loan).  To get cash, investors sell stocks, which in turn puts more downward pressure on stocks and leads to more margin calls.  It’s a viscous cycle.
• Computer Trading.  This I am less sure about.  However, since a lot of trading happens in milliseconds at predetermined prices, I don’t think it’s a stretch to say that once markets were moving down algorithms started saying “sell” making markets move down even further.

While this may not help you make a decision on how to play this – everyone is different and thus strategy will change accordingly – I hope this can help you start to wrap your head around the situation.    

Why the US Doesn’t Have the Same Issues as the Eurozone

As a follow up to my previous post on the Eurozone, I will now attempt to explain is why the US is different than the Eurozone.  Again, I am going to use a very basic example:

1. Country US and Country Emerging have different currencies.
2. Country US and Country Emerging borrow at different rates given that they have independent central banks and their currencies fluctuate freely in the market. 
3. Country US borrows money from Country Emerging; however, it borrows in its own currency.  This makes Country US’s currency depreciate in value.
4. Country Emerging wakes up one day and realizes this is lunacy and stops funding to Country US’s private sector.  This presents a problem, as Country US’s growth is dependent on this funding.
5. Given Country US has a different currency than Country Emerging they print money and inflate/devalue their currency, increase competitiveness, and boost exports, which reduce the debt burden and help growth.
6. To further ease the slowdown, Country US’s government spends money in order to keep growth from plummeting.  Given they print their own currency and have debt denominated in their own currency, they are not dependent on Country Emerging to fund their government.  Thus, they can continue to borrow.
7. As a result, Country US has the ability to increase government spending, helping the economy grow or at least hamper the slowdown.

The Eurozone Problem – A Three Minute Lesson

This is an incredibly difficult topic to understand. Cullen Roche presents it succinctly here; however, for this post I am going to use a very basic example and really simplify this complicated issue down:

1. Country ABC and Country XYZ have the same currency, but broadly speaking, Country XYZ is a more risky place to invest. 
2. Given that they share the same currency and central bank, when things are good Country XYZ can borrow at the same low interest rate as Country ABC. 
3. Because Country XYZ is more risky, the private sector takes on more debt (if you should be borrowing at 7% and you can borrow at 2%, you borrow more), which is often lent to them by Country ABC.
4. Country ABC wakes up one day and realizes this is lunacy and stops funding to Country XYZ’s private sector.  This presents a problem as Country XYZ’s growth is dependent on this funding.
5. Given Country XYZ shares the same currency as Country ABC they can’t inflate/devalue their currency, increase competitiveness, and boost exports, which would reduce the debt burden and help growth.
6. As a result Country XYZ must have the government spend money in order to keep growth from plummeting.  However, given they don’t print their own currency they are dependent on Country ABC to fund their government.
7. Country ABC won’t fund Country XYZ’s government given the massive drop off in growth and high debt burden.
8. Country XYZ has to cut government spending, reducing growth further and creating a vicious cycle.
9. Country XYZ may have to leave the currency, devalue, default, and suffer a lot of pain before ultimately recovering or…
10. Continue to cut spending, stay in the currency, and have a drawn out stage of low/negative growth.

In my next post I will compare and contrast the Eurozone with the US.  Here’s a hint: while we have our own problems, at least we don’t have these.

Greek Follow Up

So Greece passed an austerity package and it appears that they will get a bailout from Germany and France.  I expressed my concern in the past about the perils of a Greek default and now that it is “resolved”, I feel a quick follow-up is necessary.

I get the sense from my readings that this won’t solve anything long-term.  The problem still exists (Greece can’t pay back their debt) and has probably been pushed down the road. 

At the same time, the situation in Greece seems to be getting more combustible.  I do wonder if (maybe when?) more cuts are needed down the road how the people will react.  Will the government be thrown out, making default inevitable?

That said, the delay does give holders of Greek debt more time to adjust their positions, strengthen their capital base, and hedge accordingly.  Basically, a slow moving train wreck is better than a quick one in this instance (e.g. 2008).  It should contain the damage I outlined in my previous posts (linked above); “should” being the key word in that sentence.   Maybe I am being too optimistic. 

Time will tell on this.  For now, this is a positive. 

Managers Focused On Risk

A recent poll by the Economist Intelligence Unit and BNY Mellon (via FT) gave 800 institutional investors and executives various economic/geopolitical themes.  They were then asked how likely they thought each theme was and what impact that theme would have on their portfolio.   Below are some of my key takeaways:

• Many of the themes were rated as “Highly Negative” in terms of the impact on their portfolio.  To me this signifies the heightened risk aversion given the global financial crisis of 2008.
• The only “Likely” positive impact theme was that the internet and social media will be a catalyst for economic change around the world.  This always appears to be the case – a technological advancement stimulates global growth.
• The only “Highly Likely” and “Highly Negative” theme was unrest in the Middle East.  When is this never likely or negative? 
• A sovereign default is toeing the “Unlikely” and “Likely” line while being highlighted as negative.  You can read in my Greek posts here and here why that might be bad.
• Any theme involving Emerging Markets is either in the “Highly Positive” or “Highly Negative” categories or close to it, which shows the growing interconnectedness of the global economy/markets, the rising dependence on those markets for growth, and/or the increasing stakes portfolio managers have in those markets.
• There was one theme that highlighted the risk of monetary or fiscal tightening.  That is one of my concerns. 

You may have noticed, I like lists and graphs as they are not only fun to look at, but also can provide some good data that would have slipped through the cracks.  This one in particular was good because it highlights many themes and risks that are often overlooked, but need to be considered when constructing a portfolio.